Moving Averages Explained (PDF)

MOVING AVERAGES  Contrast various types of moving averages used in trend analysis. Illustrate four ways moving averages are Moving used by technicians. Averages Analyze trend movement using Directional Movement Indicators....

MOVING AVERAGES  Contrast various types of moving averages used in trend analysis. Illustrate four ways moving averages are Moving used by technicians. Averages Analyze trend movement using Directional Movement Indicators. Compare common envelope, channel, and band indicators. Copyright © 2019 Optuma Pty Ltd 2 Simple Moving Average (SMA) Moves in the market can be large. Moving It is “lagging” because a jump to a new averages can smooth out erratic data price is reached slowly over the 10 days. making trends easier to see. Shorter periods are “faster” and longer A 10-period Moving Average (MA) is periods are “slower”. Slower MAs are less simply the average of the previous 10 susceptible to “outlier” data and less likely values. to pick up false trends. The 10 periods is a “window” that is Rising Moving Averages signify uptrends moved across the data set. Each time it is and falling -> downtrends. moved, the average value is marked on the chart and the marks joined. Copyright © 2019 Optuma Pty Ltd 3 Multiple Moving Average Using a crossover of two Moving averages helps an Analyst take advantage of the responsiveness of the short MA while waiting for the crossover. A great strategy for a trending security. In sideways markets, there can still be whipsaw. Should revert to patterns at this point. Copyright © 2019 Optuma Pty Ltd 4 Weighted Moving Average (WMA) Sometimes called Linearly Weighted Moving Average (LWMA). Gives extra weight to the recent data. Most recent price, in a 10 period WMA, is multiplied by 10. The previous price is multiplied by 9 and so on. The values that are added up are then divided by 10+9+8….+2+1 = 55 Copyright © 2019 Optuma Pty Ltd 5 Exponential Moving Average (EMA) Exponential does not drop off the earliest First we calculate the weight for the data. All data is considered in the current price. calculation. This is to avoid the drop-off effect where The weight to be applied to the previous signals can be generated because of the EMA value is just 100 - Weightprice. values removed, rather than the ones added. If periods is 10, then Weightprice = 18.18% and WeightEMA = 81.82% EMA doubles the weight of the current price and applies the remaining weight to the previous EMA value. Copyright © 2019 Optuma Pty Ltd 6 Exponential Moving Average (EMA) EMA reacts much faster to turns than SMA without following the data as closely as a WMA. For period 11, we only need the price on day 11 and the EMA from day 10. EMA is used as the base in many indicators. Copyright © 2019 Optuma Pty Ltd 7 Wilder Moving Average Developed by Welles Wilder in 1978. Multiplies previous value by (Periods - 1) and adds that to current price before dividing by Periods. Lags behind other MAs. Copyright © 2019 Optuma Pty Ltd 8 Geometric Moving Average (GMA) Mostly used in Indexes. Calculation Multiply all the values Raise to the power of the inverted count It is a simple moving average of the percent changes between the previous price and the current price. If you had four numbers, then raise to ¼ Also good for datasets with extreme price or 0.25. variation as lower prices given more weight. Difference to Simple MA is negligible. Still has all the same issues of Lag and equal weight. Copyright © 2019 Optuma Pty Ltd 9 Centered Moving Average Used heavily by J.M. Hurst to help in the identification of cycles. Is a Simple Moving Average that is offset by half the period of the moving average. Means that the value is the average of that data on either side. Is not practical for crossovers like other Moving Averages. Last Periods/2 values are subject to change. Copyright © 2019 Optuma Pty Ltd 10 Triangular Moving Average Refers to creating moving averages of moving averages. Takes a SMA and then calculates a SMA with half the period length. It better reflects the trend, but lags more. Copyright © 2019 Optuma Pty Ltd 11 Triangular Weighted Moving Average Applies higher weight to the middle of the look back period. For a 20 period Moving Average, the 10th period would have the greatest weight. Copyright © 2019 Optuma Pty Ltd 12 Variable EMAs Same as the weighting scheme in an EMA but the weights are adjusted. Attempts to adapt to volatility to reduce false-signals. Copyright © 2019 Optuma Pty Ltd 13 Moving Average Summary Simple Moving Average A simple average of the past X number of bars. Weighted Moving Average A moving average where the most recent price, in the past X number of bars, is multiplied by X. The next previous bar by X-1 etc. Exponential Moving Average A moving average that applies weights to the current price and the previous EMA value. This helps avoid the drop-off effect that other averages are subject to. Wilder Moving Average A MA that multiplies previous value by (Periods - 1) and adds that to current price before dividing by Periods. Geometric Moving Average Used in indexes. Is a simple moving average of the percentage changes. Centered Moving Average Is a Simple Moving Average that is offset by half the period of the moving average. Copyright © 2019 Optuma Pty Ltd 14 Using Moving Averages 1. As a measure of trend. If the current price is above the MA, then the trend is up. 2. Determining support and resistance and trend breaks. A long term MA can trail behind the market and act like support (Bull Market). Can also be used as a trailing stop. 3. Determine Price Extremes. Prices tend to return to their average (mean reversion) Copyright © 2019 Optuma Pty Ltd 15 Using Moving Averages 4. Giving Specific Signals. Either by price Of the four ways to use Moving Averages, crossing an average or two different Trend determination is the most sensible. lengthened averages crossing. Dow’s original theory of finding the main These can be profitable in strong trend and trading with it still holds. trending markets but profits are usually wiped out in sideways markets. Copyright © 2019 Optuma Pty Ltd 16 Directional Movement Developed by Welles Wilder in his book New Concepts in Technical Trading Systems. Wilder compared one bar’s trading range with the previous bar’s to measure trend. -DM is calculated from the lows. Positive directional movement happens Inside bars are ignored and both ranges when the current bar’s high is greater than measured for outside bars. The biggest the previous bars’ high. range wins. The amount that is added to +DM is the A value can only be added for +DM or -DM distance between the highs. but not both on the same day. Copyright © 2019 Optuma Pty Ltd 17 Directional Movement Indicators Calculate the 14-period average using the Wilder Moving Average for +DM and -DM. Wilder also calculated a 14-period ATR (Average True Range). DMI+ is the ratio between the smoothed +DM and the ATR. This gives the percentage of true range that was above equilibrium. This is repeated for -DM -> DMI- Copyright © 2019 Optuma Pty Ltd 18 Directional Movement Indicators When one DMI is higher than the other, the trend is in that direction. i.e. When DMI- (red) is above, trend is down. Areas in Green shading are where trend is sideways. There is not a clear cross of the lines. Wilder suggest putting a stop just under the price where they first cross. Extreme readings mean that trend is at an extreme. Copyright © 2019 Optuma Pty Ltd 19 ADX – Average Directional Index DX is the absolute difference between the DMI+ and DMI-, divided by the sum of the two values. ADX is the moving average of the DX values. When ADX is rising, trend is increasing (in either direction). ADX measures the strength of the trend while the DMI’s show the direction. ADX is very responsive to changes in trend by showing peaks. Copyright © 2019 Optuma Pty Ltd 20 ADX – Average Directional Index ADX Peaks and Troughs are used as Trading Signals since they coincide with reversals. They are a great way to pinpoint the end of a trend - either up or down. There is an inevitable delay before you know the peak is set. We have to be real! Troughs tell us when the market is dormant. Copyright © 2019 Optuma Pty Ltd 21 ADX – Trading Rules Only trade long when DMI+ > DMI- Don’t use trend following strategies when ADX is pointing down. ADX below both DMI lines represents a flat market. The longer it stays below, the better the accuracy of the move out. When ADX rises above both lines, it shows the market is “waking up”. ADX crossing the lower of the DMI lines is the best signal to enter. Copyright © 2019 Optuma Pty Ltd 22 Moving Average Trading with ADX We know that Moving Average strategies work well in trending markets. If we only use Moving Average Systems when the ADX value indicates a strong trend, we will get better results. Green - Close Crosses MA(20) Red - Adds ADX > 20 Copyright © 2019 Optuma Pty Ltd 23 Envelopes Moving Averages represent the average price of the security. Prices actually oscillate around this average. Envelopes are used to create a filter to reduce unprofitable trades from MA crossovers (whipsaw). Calculated by taking a percentage of the MA above and beneath the Moving Average. Does not account for volatility. Copyright © 2019 Optuma Pty Ltd 24 Bands Bands are envelopes that use a volatility adjusted calculation to determine the size of the envelope. Can use Standard Deviation or ATRs to measure volatility. Most common is Bollinger Bands which uses Standard Deviation. 20 Period SMA with 2 SDs above and below. Copyright © 2019 Optuma Pty Ltd 25 Bollinger Bands +/- 2 SDs should account for 95% of price action (if prices were “Stationary” and “normal”). Price oscillates between the band extremes. High and Low breaking through the bands can be used as a signal. Copyright © 2019 Optuma Pty Ltd 26 Keltner Channels – STARC Bands Again based on the Moving Average. Then Calculates the average of the bar range. Not quite ATR, but very similar. STARC Bands do use Traditional ATRs in the calculation. Copyright © 2019 Optuma Pty Ltd 27 Trading with Bands and Envelopes Bands are traditionally used to identify the beginning of a trend. They are not usually used for Range Trading. When the outer band is broken, the entry should be in the direction of the break. This breakout is much like the breakouts in other chart patterns. The central Moving Average can be used as a stop. Longer time frames on the Bands produces more profitable systems. Copyright © 2019 Optuma Pty Ltd 28 Bandwidth Indicator The distance between the high and low band is a good indicator of volatility. Periods of high volatility are easily displayed. Breakouts from chart patterns can be confirmed with increased volatility. Copyright © 2019 Optuma Pty Ltd 29 Donchian Channel Indicates the Highest High and the Lowest Low over the past four weeks. Breaks of the line can also be treated like breakouts from traditional patterns. This is typically a Stop and Reverse System. Copyright © 2019 Optuma Pty Ltd 30  Contrast various types of moving averages used in trend analysis. Illustrate four ways moving averages are Moving used by technicians. Averages Analyze trend movement using Directional Movement Indicators. Compare common envelope, channel, and band indicators. Copyright © 2019 Optuma Pty Ltd 31